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Why invest in thematic ETFs?

Why invest in thematic ETFs?

33 of the 36 thematic ETFs listed in Europe outperformed the MSCI World index in 2020.
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2 FEB, 2021



Thematic ETFs in Europe emerged as one of the big winners in 2020; eye-catching returns helped attract a record EUR 9.5 billion in net new assets across the year. These strong flows helped assets under management more than double from EUR 8.2 billion to an all-time high of EUR 22.7 billion.

European Thematic ETF Assets

Source: Morningstar Research. Data as of 01 January 2021.

Thematics Post Stellar Returns

In a turbulent year for markets, thematic ETFs were some of the standout performers. Thirty-three of the 36 Europe-listed thematic ETFs outperformed the MSCI World Index, and most by a handsome margin.

European Thematic ETF Net Asset Flows in 2020 by Theme

Source: Morningstar Research. Data as of 01 January 2021.

The iShares Global Clean Energy ETF returned an attention-grabbing 120% over the course of the year. And clean energy wasn't the only theme to win big—many funds with a technology theme have also benefitted from the lockdown as the coronavirus pandemic spread around the world. For example, the WisdomTree Cloud Computing ETF returned 92% and the VanEck Vectors Video Gaming & eSports ETF returned 68%, boosted by the surge in remote working and demand for online entertainment, respectively.

Five Best-Performing Thematic ETFs in 2020

Source: Morningstar Direct. Data as of 01 January 2020.

With Return, Comes Risk

While you can clearly win big if you pick the right thematic ETF at the right time, losses can be large, too. For example, the L&G ROBO Global Robotic and Automation ETF lost 16% in 2018 before gaining 32% the following year. It is important to understand the characteristics of your ETF before including them in your portfolio.

Evaluating Thematic Funds

The first port of call when evaluating a thematic fund is the theme itself. First and foremost a robust theme should be logical. Is the narrative convincing? Is there a coherent and compelling growth story behind the strategy? Is there data to back it up?

A robust strategy should be loose enough to adapt, as the specifics of the chosen theme inevitably evolve through time. Will the 5G ETF still be technologically relevant in a ten years’ time? On the other hand, it shouldn’t be so loose that it dilutes any potential gains or becomes too similar to often cheaper, plain-vanilla existing sector or broad equity strategies.

Over what time frame is the theme expected to play out? How will you know when to exit? Having preset exit criteria based on robust metrics, such as valuation ratios, will help protect against poor investment decisions. These should be monitored regularly.

It is also important to understand the key risk and return drivers embedded in the theme. For example, when investing in a cannabis fund it would be important look beyond the growth projections and to fully understand the regulatory risks associated with that theme.

Once these unique risk and return drivers have been isolated, it should be determined whether they are either complementary or redundant when framed within an investors’ portfolio.


A strong narrative should not distract us from looking more closely to see exactly how well a fund tracks its theme.  

While at face value the theme in question may be intuitive and appear to have durable investment merit, it might not be possible to capitalize on it via publicly traded stocks. This is because there are often few firms that represent pure plays on any given theme. And even if they do, their exposure to the theme’s growth might already be priced into their shares. 

Also, for any given theme there tends to be several different approaches to harnessing it. Funds tracking a similar theme can end up being very different from one another.

Assessing Performance

The idiosyncratic nature of most thematic funds means that finding an appropriate benchmark or robust peer group against which to evaluate performance can be tricky.

Some themes, such as water, alternative energy and agriculture, have been around for long enough and have attracted enough direct competitors to merit their own Morningstar Categories. In this case, a performance-based peer comparison is relatively easy.

But for themes such as robotics and ageing population, where no ready-made peer-groups exists, things get a little more complicated. It is possible to create a peer group based on sector or revenue exposure and intentionality, although the parameters used may vary from investor to investor and require monitoring through time.

Others, such as the LSE-listed L&G Battery Value-Chain ETF [BATT], lack direct competitors. In this case, a broad equity benchmark like the MSCI World Index or specific sector indexes may be most appropriate.

Odds of Long-Term Success low

Our own research has shown that the odds of picking a thematic fund that outperforms a low-cost global equity index fund over long-time horizons are stacked firmly against the investor.

Globally, just 45% of all thematic funds launched prior to 2010 had survived to see 2020. Of these, only a quarter managed to beat the MSCI World Index.

Ones to Watch

The case for investing in water is compelling. Fresh water is not distributed equitably across population centres, nations or regions. Moreover, given its weight, water is not easy to transport in sufficiently large quantities.

As populations continue to grow, supply and demand for water is set to become progressively more imbalanced especially in arid regions with contaminated water. For regions with easily accessible water resources like rivers and underground aquifers, the risk of overconsumption and inefficient recycling are real threats to the sustainability of these resources. These constraints pose a global profit opportunity.

Unlike other water ETFs, which often have large allocations to utility companies like Veolia, the L&G Clean Water ETF tilts towards those firms providing technological or digital solutions to water concerns.

Elsewhere the iShares Ageing Population ETF, which took the largest hit during the Covid-19 inspired market turmoil is worth consideration as a value play for those with a longer-term investment horizon. The fundamental drivers of ageing populations in the developed world remain in place, despite recent developments.

The iShares Ageing Population ETF selects stocks globally based on their exposure to the ‘grey economy’. This means it invests in stocks as diverse as UK-based over-50s specialists Saga plc, Australian Funeral Home provider InvoCare Ltd and US-based travel and restaurant website TripAdvisor.

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